When to Incorporate? Part 1

In my last blog we discussed Why Incorporate?  This completely ties into when to incorporate as you will see from this blog.  There is no absolute answer to “When to Incorporate?” as everyone’s situation is different, however these are some general guidelines to help you know when it’s right for you to incorporate.  Let’s look at the 3 reasons that people incorporate and how they tie into when to incorporate.

The first is tax savings as incorporations that earn active income receive what’s called the Small Business Deduction which allows Corporate Income taxes (Federal & Provincial combined) to be as low as 14% in Alberta (currently). This low tax rate on active income earned in a corporation is static up to $500,000 active net business income.  Once you make over $500,000 in a corporation you pay a significantly higher tax rate, but most corporations will never need to go over $500,000 in net income (after expenses).  If you see in your projections that your corporation will exceed $500,000 it is essential that you plan in advance to look for ways to avoid this.  For example you may structure 2 separate, non-related, corporations to provide 2 separate products or services your one corporation may have provided so each could stay under the $500,000 Small Business Deduction Limit.

Individuals, on the other hand, have what’s called a Graduated Tax system, which means there are tax brackets that make individuals earning more income pay higher rates of tax.  There are various levels that trigger the higher rates of tax, and there are even personal tax exemptions that allow you to pay no tax if you have very low income.  This is why a lot of people start as sole proprietors because they will pay less personal tax as sole proprietor that earns up to about $30,000 of net income (not including income splitting in Alberta).  Once you make about $30,000 in your corporation it changes and you can now save more tax using a corporation.  This is because shareholders of the corporation can receive about $30,000 in tax free dividends from a private corporation before paying tax if this is there only source of income.  Not only is there no personal tax on the dividends, but also no EI or CPP.  This means at around $30,000 you typically only pay the corporate taxes at a lower rate, even if you (the shareholder) has pulled out all of the $30,000 made in profit.  There is one more factor to consider: Accounting Costs!  Accounting Costs for a corporation are much more than individual costs as there both Federal and Provincial Tax returns that must be done for a corporation and they are much more complex than personal tax returns.   Not to mention full accounting must be done for corporations, including assets and liabilities, and financial statements are prepared, along with schedules and minutes for the corporation’s minute book.  Although you are saving tax at $30,000 net, if you include the accounting fees against the savings you are looking at incorporating around $35,000 net to save taxes (including accounting fees).  This way you will be saving more than you pay the accountant! At Kustom Design our goal is to always save you more than you pay!

Please check back for the next installment of the “When to incorporate” blog series.

Why Incorporate?

There are many reasons to incorporate, which really break down into 3 areas.  The 1^st area is tax savings.  Corporations can save taxes in many ways and we will go deeper into the area of tax savings throughout this series of blogs.  Corporations can pay as little as 14% total federal and provincial tax on active income up to $500,000 in Alberta.  All provinces and territories across Canada have attractive tax savings at different levels using corporations.  You can also avoid payroll remittances and extra costs such as EI and CPP with the utilization of dividends.  Shareholder loans are a very powerful tool of a corporation and are tax free.  You can sell assets to the Corporation at Fair Market Value and receive the amount now or in the future from the corporation tax free.  As you will see throughout this series there are many ways to save and defer taxes through a corporation.  In the next series we will discuss when to incorporate and part of this will include the timing of incorporation for tax purposes, which in Alberta is about$30,000 - $35,000 net income if this is your only source of income.  If you have other sources of income or if you corporation will grow quickly, then you may want to incorporate right from the start.  We will discuss this in my next blog.

The 2^nd area of reasons to incorporate has to do with liability protection.  When you incorporate you set yourself up for limited liability. Unlike partnerships where partners are usually personally liable for the business acts of their partners, corporate shareholders are typically not personally liable for the acts of the directors, officers or other shareholders of the corporation.  The director takes the liability and that is typically only liability for anything that is personally guaranteed by the director, government agency debts or debts that arise from environmental damage.  For further liability protection your corporation can be owned by trusts and holding companies.  For more on trusts see my blog series on the family trust.

The 3^rd area of reasons to incorporate has to do the fact that incorporation makes your business more attractive.  Many businesses seek to do business with corporations over sole proprietorships.  If you need capital from investors or the bank you will have much more of a chance of receiving it as a corporation.  Also some corporations will not hire sole proprietors for the job as CRA could deem sole proprietors as employees in some situations, which creates a huge CRA payroll debt!  Overall corporations are more attractive to do business with.

In my next blogs we will get into the timing of setting up a corporation and structuring your corporation.

Introduction to the Blog Series: "Understanding the Corporation"

A corporation is an entity created by a person or a group of people for the purpose of creating a separate legal entity for themselves.  In other words, when a corporation is created it has a separate existence from any individuals, although it is set up and ran by individuals or groups of people.  This separate legal existence allows for liability protection, tax savings and estate planning to the extent that the jurisdiction where the corporation is set up allows within its rules and laws.  Although Corporations exist in countries all over the world, they are all similar in nature.  Also, a lot of provinces states and countries offer different types of corporations for different purposes.  For example, in The United States Corporations come in many forms such as Limited Liability Corporations (LLCs), S Corporations, C Corporations and more.  In Canada the main Corporations we use are Canadian Controlled Private Corporations (CCPCs), Professional Corporations, Public Corporations, Non Profit and Charitable Corporations.  In the scope of this series we will mostly be discussing the CCPCs as these are the Private Corporations that the everyday Canadian uses.  The other types of Corporations share similar traits and have similar rules so these blogs do have application to the different types of Corporations, and as usual if you have questions you can contact me.

In this series we will go cover what a corporation is, how to understand the basics of a Corporation, why and when to incorporate, ways to structure corporations, steps on incorporating, working with a corporation, maximizing the use of a corporation and how to sell, dissolve(close) or pass on an incorporation.  This is a much needed series that I know will educate and assist many.